8 Pros and Cons of Starting an LLC

When you're just starting a side-hustle or business, deciding what type of company to run can feel a bit intimidating.

Are you a sole proprietorship doing business as yourself, or as another name? Or perhaps a C corp, S corp, or LLC better-suits your needs. But how do you know for sure?

Depending on which country or state you operate your business in, the fine details may change, so take these tips as general information and check with an expert in your area for more details before taking any actions.

Choosing Between Sole Proprietorship and Incorporation

For most early-stage entrepreneurs, the first decision you'll need to make is whether to run a sole proprietorship or to incorporate. 

The good news is, you can always start with a sole proprietorship and incorporate later so as your business grows you can grow with it.

When just starting out, a sole proprietorship makes a lot of sense—it's straightforward and requires little administration to get going. You have complete control and are directly responsible for everything that happens in your business. Both your income and expenses are reported on your personal tax return, so you avoid business-related tax filing costs and other similar administrative charges.

However, as your business grows, it will make more financial sense to incorporate for a number of reasons, including a lower tax rate and removing personal liability. Although incorporating likely won't change how you run your business, this process enables your company to become a legally separate entity from you, the owner. Incorporation protects your personal assets and can also boost your credibility with clients and customers.

What is a Limited Liability Company (LLC)?

Once you decide to incorporate, the next decision you need to make is what type of corporation or company will you register?

In the United States, there are a few business types to choose from, including C corporations, S corporations and limited liability companies (LLC).

Corporations are most often chosen when companies are looking for venture capital funding, profit-sharing or stock options among multiple owners or shareholders, or want to take advantage of other tax benefits.

The LLC business type is similar to an S corporation tax-wise, but allows for more flexibility in accounting, administration and management than corporations.

Pros and Cons of Starting an LLC

Becoming an LLC is the natural next step for many sole proprietors. This limits the business owner's personal liability, allows owners to oversee business operations and affords what's known as pass-through taxation.

5 pros of starting an LLC

● Limited liability

LLC owners (called members) are protected from personal liability, which means creditors are prevented from pursuing personal assets—such as your house, vehicles, savings accounts, etc.—for business debts.

● Limited compliance requirements

In the United States, LLC's experience less compliance requirements than corporations do, making the administrative load lighter.

● Flexible ownership

When you incorporate as an LLC, you can structure your membership in a variety of ways including individuals, partnerships, trusts or corporations. In contrast, incorporating as a C or S corporation includes many more restrictions for how the corporation is structured.

● Flexible management

Incorporating as an LLC allows you, the business owner, to continue overseeing the day-to-day business operations, rather than having a board of directors manage the business like would be required in a corporation business type.

● Pass-through taxation

One big benefit of running an LLC is business income and loss can be passed through to owners to report on their personal taxes, which can reduce the amount owed. In this scenario, taxes are paid at an individual level rather than at a business-entity level.

3 cons of starting an LLC

● Ongoing costs

Although start-up costs for an LLC are much lower than a C corporation or S corporation, there are still initial and maintenance fees, which a sole proprietor would not have to pay.

● Compliance obligations

Again, although there are fewer administrative obligations for LLC's than there are for C corporations and S corporations, there are still regular filing requirements that are not required for sole proprietors.

● Adding or removing members

Starting an LLC is straightforward, but the process for adding or removing members can be cumbersome as all existing members must agree to the changes. In contrast, a corporation would simply sell or transfer stock to increase or decrease ownership.

For entrepreneurs who want to protect their personal assets and see their company grow through reinvestment, incorporation is a good idea. 

It's the natural next step after a business idea is vetted and it's time to scale to include any number of additions such as multiple owners, additional funding, tax-planning opportunities and building credibility in the marketplace.

The decisions for whether to incorporate and which business type to choose comes down to what's best for the company. Businesses looking to grow and expand will find there are significant benefits to pursuing incorporation.


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